The most popular – and safest – mortgage option is a repayment mortgage, where the monthly payments are made up of a proportion of the capital advanced and the interest on that capital. However, these days, interest only mortgages are becoming more popular. So when is it a good idea to opt for an interest only mortgage?
Buy to let
If the intention is to buy a property with the express intention of renting it out, an interest only mortgage is a viable option. The rental income will cover the mortgage payments, and the capital can be repaid when the property is sold. This is a particularly good choice for people who have bought a house at auction at a low price, then renovated the property to increase the value.
First time buyers
An interest only mortgage is a good way to get on the property ladder, as the monthly payments are lower than a repayment mortgage. However, it’s a solution for the short term rather than the long term, and you should convert to a repayment mortgage when circumstances allow.
In lean times
If money is tight, an interest free mortgage is considerably less expensive than a repayment mortgage. For example, a £200,000 mortgage at 5% interest will cost you £1,169 a month on a repayment basis and £833 paying just the interest.*
This means there is less chance of falling into arrears and damaging your credit score. If repayments are affordable, this also minimises the risk of repossession of the property.
Buyers with prospects
If you are expecting a significant increase in income – perhaps because of a qualification, or the maturity of an investment – an interest only mortgage is a good short term option. Because the payments are lower, it’s possible to borrow more money. Therefore, you can purchase a more expensive house, or a house in a better area, without having to wait for the raise in income or the investment or inheritance to materialise.
Flexibility of repayment options
If you know of a great investment opportunity which will yield enough to pay off the capital sum on your property and also leave a lump sum for your own use, an interest only mortgage may be right for you. It’s a chance to capitalise on the value of your property, but be sure to check that your investment is keeping pace with inflation and that there will be enough to pay off the capital at the end of the mortgage.
When house prices are low
An interest only mortgage is a good option when house prices are low following an economic slump. If the property price is low, the only way is up, and there is less risk that the sale of the property will fail to repay the capital sum of the loan.
Cheaper than renting
In locations where property prices are high, such as London and the south east of England and coastal areas of Cornwall and Devon, it may be cheaper to buy with an interest only mortgage than to rent. And of course, you will be on the property ladder. However, unless you also pay into a savings account or pension fund to pay back the capital, you are, in effect, renting from the bank rather than an individual property owner or housing association.
An interest only mortgage is not ideal for every borrower, and much will depend on your individual financial circumstances. Seek the advice of an independent financial advisor, and remember that if you don’t keep up the repayments on any kind of mortgage, there is a real risk that you may lose your home.